INDIAN FINANCIAL SYSTEM

The economic expansion of any country depends upon the existence of a

well-ordered financial system. It helps in the creation of wealth by linking
savings with investment. The financial system is an organized and regulated
structure where an exchange of funds takes place between the lender and
the borrower. It supplies the necessary financial inputs for the production
of goods and services, in turn, promotes the well-being and standard of
living of people in the country.

A financial system is a set of institutions, such as banks, insurance companies, and

stock exchanges, that permit the exchange of funds. Financial systems exist on
firm, regional, and global levels. Borrowers, lenders, and investors exchange
current funds to finance projects, either for consumption or productive
investments, and to pursue a return on their financial assets. The financial system
also includes sets of rules and practices that borrowers and lenders use to decide
which projects get financed, who finances projects, and terms of financial deals.
Meaning of Financial System
The Financial System is a system that facilitates the movement of funds
among people in an economy. It is simply a means through which funds are
exchanged between investors, lenders, and borrowers. A financial system is
composed of various elements like financial institutions, financial
intermediaries, financial markets, and financial instruments which altogether
facilitate the smooth transfer of funds.

This system exists at the regional, national, and international levels. It is an

efficient tool that helps in the economic development of a country by linking
savings and investments thereby leading to wealth creation. The financial
system acquires money from people who are keeping it idle and distributes it
among those who use it for yielding income and generates wealth in the
country.

Financial system aims at the efficient allocation of financial resources by

channelizing funds between net savers and net spenders. The financial
system has an efficient role in minimizing the risk through diversification of
funds among a large number of people. 

Nature of Financial System

Nature of Financial System

1. Transfer Funds
Financial system helps in transferring of financial resources from one person
to another person. This system includes financial markets, financial
intermediaries, financial assets and services which facilitates fund
movements in an economy.

2. Mobilizes Saving
It helps in allocating ideal lying resources with peoples into productive means.
Financial system is the one which obtains funds from savers and provide it to
those who are in need of it for various development purposes.

3. Risk Allocation
Diversification of risk in an economy is important feature of financial system.
Financial system allocates people’s funds in various sources due to which risk
is diversified. 

4. Facilitates Investment
Financial system encourages investment by peoples into different investment
avenues. It provides various income-generating investment options to peoples
for investing their savings.
 5. Enhances Liquidity
Financial system helps in maintaining optimum liquidity in an economy. It
facilities free movement of funds from households (savers) to corporates
(investors) which ensures sufficient availability of fund

Role of Financial System

Role of Financial System

1. Facilitates Payment Mechanism
Financial system provides a payment mechanisms for the smooth flow of
funds among peoples in an economy. Buyers and sellers of goods or services
are able to perform transactions with each other due to the presence of a
financial system.
 2. Reduces Risk
It aims at reducing the risk by diversifying it among a large number of
individuals. Financial system distributes funds among a large number of
peoples due to which risk is shared by many peoples.

3. Brings Savers And Investors Together

Financial system serves as a means of bridging the gap between savings and
investment. It acquires money from those with whom it is lying idle and
transfers it to those who need it for investing in productive ventures. 

4. Assist In Capital Formation

Financial system has an efficient role in the capital formation of the country. It
enables big corporates and industries to acquire the required funds for
performing or expanding their operations thereby leading to capital formation
in the nation.

5. Improves Standard Of Living

It raises the standard of living of peoples by promoting regional and rural
development of the country. The financial system promotes the development
of a weaker sections of society through cooperative societies and rural
development banks.

6. Facilitates Economic Development

Financial system influences the pace of economic growth or development of
an economy. It aims at optimum utilization of all financial resources by
investing all idle lying resources into useful means which leads to the creation
of wealth.

OBJECTIVES OF FINANCIAL SYSTEM

The main objectives of financial system are as follows:
1. Mobilization of Savings
2. Allocation of Funds
 3. Development of Trade
4. Settlement of Commercial Transactions
5. Liquidity
6. Risk Protection
7. Overall Economic Development
8. Promotes Capital Formation

1.Mobilization of Savings
An important function of a financial system is to mobilize savings and channelize
them into productive activities. A financial system helps in obtaining funds from
the savers or surplus units such as household individuals, business firms, public
sector units, central government, and state governments.
Mobilization of savings takes place when savers move into financial assets,
whether currency, bank deposits, post office savings deposits, life insurance
policies, bills, bonds, equity shares, etc.

2. Allocation of Funds
Another important function of a financial system is to arrange smooth, efficient,
and socially equitable allocation of credit. Money-lenders and indigenous bankers
have been providing finance to their borrowers since long. But their finance suffers
from several defects.

With modern financial development, new financial institutions, assets and markets
have come to be organized, which are playing an increasingly important role in the
provision of credit.

3. Development of Trade
The financial system helps in the promotion of both domestic and foreign trade.
The financial institutions finance traders and the financial market helps in
discounting financial instruments such as bills. Foreign trade is promoted due to
per-shipment and post-shipment finance by commercial banks.

The best part of the financial system is that the sellers or the buyers do not meet
each other and the documents are negotiated through the bank. In this manner, the
financial system not only helps the traders but also various financial institutions.

4. Settlement of Commercial Transactions

The financial system facilitates settlement of commercial transactions & financial
claims arising out of sale & purchase of goods & services. For this money is used
as an instrument which is legally recognized. Therefore values of all transactions
including sale & purchase of goods and services are expressed in terms of money
only.

Over a period of time, the financial system has evolved other instruments like
cheques, demand drafts, credit card etc. for settlement of economic transactions.
These instruments are recognized by law as a substitute for money.

5. Liquidity
In a financial system, liquidity means the ability to convert into cash. The financial
market provides investors the opportunity to liquidate their investments, which are
in instruments such as shares, debentures and bonds. The price of these instruments
is determined daily according to the operations of the market force of demand and
supply.

6. Risk Protection
Financial markets provide protection against life, health- and income-related risks.
These risks can be covered through the sale of life insurance, health insurance and
property insurance and various derivative instruments.

7 .Overall Economic Development

India is a mixed economy. The Government intervenes in the financial system to
influence macro-economic variables like interest rate or inflation. Thus, credits can
be made available to corporate at a cheaper rate. This leads to economic
development of the nation.

8 To distribute the savings for industrial investment :-

The purpose of mobalising the funds from saving community is to invest
them in different industries. Thereby it meets the funds requirements of
industrial sector. Hence it helps in the growth of industrial sector.

9. To stimulate capital formation :-

Financial system promotes capital formation .  Capital formation increases
investment which effects economic development in two ways. Firstly, it
increases the per capita income and enhances the purchasing power which,
in turn, creates more effective demand. Secondly, investment leads to an
increase in production.
Advantages of Financial system
1. Provides Payment System: The financial system provides a
payment mechanism for the smooth flow of funds among peoples
in an economy. Buyers and sellers of goods or services are able to
perform transactions with each other due to the presence of a
financial system.
2. Links Savers and Investors: The financial system serves as a
means of bridging the gap between savings and investment. It
acquires money from those with whom it is lying idle and
transfers it to those who need it for investing in productive
ventures.
3. Minimizes Risk: It aims at reducing the risk by diversifying it
among a large number of individuals. The financial system
distributes funds among a large number of peoples due to which
risk is shared by many peoples.
4. Helps in Capital Formation: The financial system has an efficient
role in capital formation of the country. It enables big corporates
and industries to acquire the required funds for performing or
expanding their operations thereby leading to capital formation in
the nation.
5. Raises Standard of living: It raises the standard of living of peoples by
promoting regional and rural development of the country. The financial
system promotes the development of weaker sections of society
through cooperative societies and rural development banks.
6. Enhance liquidity: Maintaining optimum liquidity in an economy is
another important role played by the financial system. It facilities free
movement of funds from households (savers) to corporates (investors)
which ensures sufficient availability of funds in the economy.
7. Promotes Economic Development: The financial system influence the
pace of economic growth or development of an economy. It aims at
optimum utilization of all financial resources by investing all idle lying
resources into useful means which leads to the creation of wealth.
Disadvantages of Financial system
1. Lack of Co-ordination among financial institutions: The
financial system faces a lack of coordination among various
financial institutions. The presence of a large number of financial
institutions and government roles in controlling authorities of
these institutions leads to a lack of coordination.
2. Monopolistic Market Structure: Many institutions in the Indian
financial system occupy a monopolistic position in the market.
LIC and UTI are two institutions that have grabbed a large part of
the life insurance business and the mutual fund industry. These
large structures could lead to mismanagement or inefficiency of
funds.
3. High Rate of Interest: There is a possibility of the high-interest
rate charged by several financial institutions in the financial
system of our country. Various institutions due to their
monopolistic structure in the market may charge high or unfair
interest rates.  
4. Inactive Capital Market: Our country’s financial system faces the
problem of the inactive capital market. All corporates in India are
mostly able to acquire funds through development banks and do
not need to go to the capital market.
5. Imprudent Financial Practice: The financial system of India has
developed imprudent financial practices due to the dominance of
development banks. Development banks provide funds to corporates in
the form of term loans which makes the capital structure of borrowed
concerns uneven. These banks even permit the use of unwarranted
debts which is against the sound capital structure.